The Rating Game

Schroder Exempt Property Unit Trust and another v Birmingham City Council- [2014] All ER (D) 143

Summary

The High Court has ruled that the landlord will become liable to pay rates for empty properties following a disclaimer of the lease. 

The decision confirms that leases terminate upon disclaimer. Although the liability of third parties such as guarantors or original tenants may be preserved, it is their contractual obligations that survive, not any proprietary interest in the property. The landlord becomes entitled to possession of the premises immediately upon disclaimer, whether or not it chooses to exercise it. As such, the landlord also becomes liable for the rates.

The facts

This case relates to business premises in Witton, Birmingham ("the Premises"). In 2006, the Premises were let on a ten year lease to Woodward Foodservice Ltd ("Woodward") on standard terms, including an obligation that Woodward was liable for all outgoings, including business rates. 

In July 2008, Woodward assigned the lease to W F Group Ltd ("WFG"). Woodward entered into an Authorised Guarantee Agreement ("AGA") with the landlord to guarantee the performance of WFG. The AGA stated specifically that any disclaimer of WFG's liabilities would not affect the guarantee from Woodward.

A few years later, WFG went into liquidation and was wound up on 20 April 2011.  On the same day, the liquidator disclaimed the lease. The landlord called on Woodward to pay the rent under the AGA, which Woodward duly did.

Neither the landlord nor Woodward made any effort to occupy the Premises, which therefore remained empty from the date the lease was disclaimed. Consequently, the Council sought to recover unpaid rates in respect of the Premises from the landlord. The rates totalled approximately £590,000. When the landlord refused to pay, the Council applied for, and obtained, a liability order against it.

The landlord therefore appealed the decision to the High Court.

The law

The Court had to look at a number of statutes and previous cases. In particular, it looked at what happened on disclaimer under Section 178 Insolvency Act 1986, which states that disclaimer terminates the rights, interest and liabilities of the tenant from the date of disclaimer, but does not affect the rights or liabilities of any other party.

This meant that WFG had been released upon disclaimer, but Woodward had not.

The Court then considered Section 43 Local Government Finance Act 1988 ("the Act"). This sets out the position for liability where a property is not occupied, and identifies the ratepayer. One of the criteria is that the ratepayer must be the "owner" of the property. The first question to determine liability for rates was: Who was the "owner"?

Section 65 of the Act states that the owner is "the person entitled to possession". The Council and the landlord both agreed that the key question was therefore: Who was entitled to possession of the Premises?

In most cases, this will be simple. For example, when a lease expires by effluxion of time and the tenant vacates, the landlord becomes entitled to possession. But in this case, where there was a guarantor on the hook, the position following disclaimer was much more complicated.

The landlord's case

The landlord argued that it was not entitled to immediate possession for a number of reasons. First, although the liabilities of WFG had been extinguished upon disclaimer, the lease continued for certain purposes, such as preserving the liabilities of third parties. In this case, that was the obligations of Woodward under the AGA. 

Secondly, the landlord argued that, because of the AGA, it had to wait to obtain the right to immediate possession. This right could arise on the natural expiry of the lease, or by an election on the part of the landlord to forfeit and take back physical possession. Given that Woodward was paying the rent, the landlord did not want to terminate the guarantee. If it had entered the Premises to take back possession, this would have brought the guarantee to an end.

Consequently, although the landlord had a right to possession of the Premises, this could only apply if and when it exercised its rights under the lease. Until the landlord did so, it would not have the "immediate" right to possession. In this regard, the landlord relied on the earlier decision of Brown v City of London Corporation (Re Solomon) [1996] where the Court found that it was not enough for liability under Section 65 of the Act to have a right which he could exercise to take possession. Rather, he must be "immediately" entitled to possession.

Thirdly, the landlord argued that the payment by Woodward under the AGA would only continue for so long as the landlord was not entitled to immediate possession. As Woodward was paying the rent, this meant that the landlord could not be so entitled.

Finally, the landlord tried to argue that Woodward was in the same position as itself, because it also had a right to possession that it had not exercised, as it was the guarantor. Thus nobody currently had the right to "immediate" possession.

In summary, the landlord concluded that it was not liable for rates, as its right to possession was not "immediate". Rather it remained contingent on retaking possession, and this right had not been exercised.

The decision

The Court rejected all of the landlord's arguments and held that it was liable for empty rates in respect of the Premises.

On reviewing previous cases, particularly the leading decision in Hindcastle Limited –v- Barbara Attenborough Limited [1997], the Court held that the effect of a disclaimer was to terminate the lease. Where there is a simple structure of just landlord-tenant, this will have simple consequences. 

However, where a lease is guaranteed, the liabilities of the insolvent or bankrupt tenant are terminated, but without affecting the liability of any guarantor or original tenant. Similarly, the insolvent or bankrupt tenant's counter-indemnities to the guarantor are terminated, but not so that the rights and obligations of the guarantor are affected.

Even more important, however, is what happens to the lease. The lease, said the Court, "either exists, or it does not". And following disclaimer, it does not. However, even if the lease has ended, the liabilities of any third parties must continue "as though the lease had continued and not been determined". Consequently the rights or liabilities of other parties are protected by the law. There are a number of options available to the parties in practice, including applications for a vesting order, and continuing to demand rent as the landlord did in this case.

Thus the Court confirmed that, once the lease has been disclaimed, it comes to an end. Woodward's obligation to pay the rent stemmed from its contractual guarantee, not from a murky limbo where the lease continued purely for that purpose. At the point of disclaimer, the Court advised that the landlord therefore became entitled to "immediate possession" because the lease had ceased to be a document conferring any property rights. All it had continued to do was to preserve the contractual rights between the landlord and Woodward. 

It followed that the landlord had an immediate right to possession of the Premises because there was no lease to forfeit. The fact that the landlord had refused to occupy the Premises to preserve the guarantee was irrelevant to its entitlement to possession.

Consequently the landlord was the "owner" under the Act and was therefore the party who was liable for rates. 

Our advice for landlords

Where a tenant enters into liquidation and the lease is guaranteed, landlords should seek early advice to decide on a strategy as soon as possible.

Options will include:

  1. taking possession and releasing the guarantor;
  2. seeking rent from the guarantor and responding to an application from the guarantor to have the lease vested in its name; or
  3. seeking rent from the guarantor and allowing the premises to remain empty (as happened in this case).  

Following this case, liability for empty rates will now fall on the landlord if option 3 is chosen, subject to the usual reliefs. However, a landlord should check whether the terms of any authorised guarantee agreement in place will enable it to recover this liability from the guarantor. Otherwise, rates liability must be factored in when making a decision on whether or not to take back possession.